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Forex (FX) History: How the Modern FX Market was Born

By Frances Coppola

Many businesses have become so accustomed to tapping the global forex market for foreign currency exchange that it sometimes seems as if forex history stretches back centuries. In fact, it is a surprisingly recent system, the seeds for which were sown in the aftermath of World War II – though those FX seeds didn’t start to flower until the early 1970s.

How Long has the Forex Market Been Around?

 

Understanding forex history starts with the 1944 Bretton Woods agreement, which aimed to create a stable international financial system anchored by gold. Rather than valuing all national currencies in terms of gold – as gold standards of the past had done – only one currency was directly so valued: the U.S. dollar. Other currencies were valued in terms of the U.S. dollar at a fixed rate. Indirectly, therefore, the value of all currencies was tied to gold.

 

There was already an international gold market, in which traders could effectively speculate on the value of the U.S. dollar. But the Bretton Woods system depended on the U.S. dollar’s value in gold remaining fixed. So when the dollar came under speculative pressure, central banks had to intervene in the gold market to maintain the dollar’s peg to gold. In 1961, the eight largest central banks created the London Gold Pool to enable them to control the gold price by coordinating gold sales and purchases. From 1961 to 1968, the London Gold Pool successfully stabilized the dollar’s gold price, thus preventing the Bretton Woods system from collapsing.1

 

But the course of forex history changed in November 1967, after the U.K. government devalued sterling against the dollar – causing USD to come under sustained speculative attack. The central banks in the London Gold Pool intervened to prevent the dollar’s gold peg from breaking, by buying enormous quantities of gold in what could be regarded as an early form of quantitative easing (QE). However, the cost of supporting the dollar proved politically unacceptable. In March 1968, the London Gold Pool was terminated.2

 

After that, the market price of gold in dollars rose higher and higher. The U.S. was faced with a choice between selling ever-larger amounts of gold to maintain the dollar’s gold peg, or breaking the dollar’s link to gold. In 1971, President Nixon chose the latter course.

 

When President Nixon suspended the dollar’s gold convertibility, all currencies lost their link to gold. For the first time in forex – or any – history, currencies could only be valued in terms of each other. From that moment on, the gold market played no role in international foreign exchange. Instead, traders exchanged currencies directly and, thus, the modern forex market was born.

 

Floating Rates and Technology Change Forex History Again

 

After the end of Bretton Woods, it took more than 20 years for Western governments to abandon all fixed-exchange rate systems; by 1998, however, most had adopted floating rates. Central banks still intervened in forex markets to stabilize their currencies at times of high volatility. But, increasingly, central banks used interest rate policy to influence the behavior of forex market traders, rather than directly managing exchange rates. For the first time in forex history, forex market trading, rather than government policy or the value of a commodity, determined foreign currency exchange rates.

 

In parallel with this, technological advances brought fundamental change to forex market history. In the 1970s and 1980s, forex trading was restricted to large banks and financial institutions; non-banks could only access the forex market via a banking relationship. But in the 1990s, as the Internet spread around the world, banks and small companies started to create online networks to produce automated quotes and trade instantaneously. Around the same time, online trading platforms started to appear, enabling individuals to trade in FX markets for the first time. Between 2000 and 2010, the forex market grew enormously, as new types of brokerage and electronic dealing platforms extended forex trading capabilities to an increasing number of small participants.3

 

Additionally, deregulation of financial markets from the 1980s onward added increasingly sophisticated forex products. FX hedging products helped businesses to manage foreign-exchange risk even in volatile currencies, while derivatives created profit opportunities for traders.4

 

The

Takeaway:

Since the end of the Bretton Woods system in 1971, when modern forex history begun, the forex market has changed multiple times. In the distant past, currency exchange rates were set by governments, and forex was regarded mainly as an aid to international trade. Today, most major currency exchange rates are market-determined, while central banks use interest rate policy to influence forex market behavior. The Internet and online platforms now enable small traders and brokers all over the world to participate in the forex market. Finally, today’s sophisticated online tools, analytics, and brokerage services help businesses to manage their own FX risk and liquidity.

Frances Coppola - The Author

The Author

Frances Coppola

With 17 years’ experience in the financial industry, Frances is a highly regarded writer and speaker on banking, finance and economics. She writes regularly for the Financial Times, Forbes and a range of financial industry publications. Her writing has featured in The Economist, the New York Times and the Wall Street Journal. She is a frequent commentator on TV, radio and online news media including the BBC and RT TV.

Sources

1. “The limits of central bank cooperation: evidence from the London Gold Pool 1961-68,” VoxEU; https://voxeu.org/article/limits-central-bank-cooperation-evidence-gold-pool
2. Ibid.
3. “The Modern Foreign Exchange Market,” Foreign Exchange Professionals Association; https://fxpa.org/wp-content/uploads/2015/09/fxpa-overview-7-15.pdf
4. “History of the Forex Market,” IC Markets; https://www.icmarkets.com/education/history-of-the-forex-market/

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